Street Blue on Red Hat

Red Hat said it expects to generate between $34 million to $37 million in cash flow from operations in the fourth quarter. That's up from the $29.7 million in cash flow from operations in the third quarter, which failed to meet the company's targeted range of $32 million to $34 million.

The new subscriptions count also proved disappointing. The company said total subscriptions reached 132,000 units, including 119,000 enterprise subscriptions. That's down from 144,000 total subscriptions in the previous quarter. One analyst, Prudential Securities' Brent Thill, had expected enterprise subscriptions alone to total 131,800 by the end of the quarter. (Thill raised his rating on Red Hat to overweight from neutral weight on Nov. 29; his firm doesn't do investment banking.)

Analyst estimates for how many of those enterprise subscriptions were new (vs. renewals) ranged from 74,000 to 89,000 -- roughly flat to down from their estimates for the previous quarter.

One bright spot in the quarter was deferred revenue -- a key measure of subscription sales -- which climbed $21.7 million, or 22%, sequentially to $121.4 million, driven by strong sales bookings. That also could reflect the company signing an increasing number of multiyear contracts, analysts said.

With pricing pressure in the Linux server market a big concern on Wall Street, analysts peppered Red Hat executives about pricing trends and renewal rates, which the company has stopped tracking.

CFO Charlie Peters would only say that "pricing has been relatively stable." He also noted that about 20% of bookings were for subscriptions of more than one year, in which the company may charge less per unit to reflect the savings from not having to resell to the customer within a year.

But such comments failed to comfort analysts. "Price erosion could intensify as competitive products launch in the first-quarter calendar 2005 and as multi-year contracts with meaningful discounts become a more significant portion of bookings," noted SIG analysts Jason Kraft and Chris Kwak, who maintained their neutral rating on Red Hat. They estimated new enterprise subscription average selling price has fallen to $390 from $525 over a one-year period. (Their firm doesn't do investment banking.)

Competitive pressure has been intensifying with an announcement from hardware vendor Dell(DELL) in October that it would offer a Novell version of Linux as a standard product at a much lower cost than Red Hat. In addition, Sun said last month it will offer the next version of its operating system, the most commonly deployed commercial version of Unix for servers, for free.

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